Public Bill Committee

[Mr. Jim Hood in the Chair]

(Except clauses 3, 5, 6, 15, 21, 49, 90 and 117 and new clauses amending section 74 of the Finance Act 2003)

Mark Hoban: On a point of order, Mr. Hood. It is a pleasure to serve under your chairmanship this morning. Last Wednesday, the Treasury kindly sent members of the Committee explanatory notes on several schedules to which amendments have been proposed. In the main, it is easy to compare the explanatory notes with the amendments as tabled. However, it is not possible to link to the explanatory notes several amendments that have been tabled to schedule 17, which we might debate this afternoon. Can the Treasury supply members of the Committee with information that cross-references the explanatory notes and the amendments, so that those who wish to participate in the debate on life assurance taxation can do so?

Jimmy Hood: I thank the hon. Gentleman. That is not a point of order, although I am sure that the Minister heard what he said and may well respond.

Clause 28

Enterprise investment scheme: increase in amount of relief

Question proposed, That the clause stand part of the Bill.

Mark Hoban: The clause increases the limit for enterprise investment schemes from £400,000 to £500,000. It is one of a series of changes that have been made since the scheme was introduced in 1993. The limit was increased to £150,000 in April 1998, to £200,000 in April 2004, and to £400,000 in April 2006. Can the Minister advise the Committee why the Treasury increased the limit to £500,000, not to any other amount? The scheme is covered by European Union state aid rules and the clause makes it clear that the increase is subject to approval by the EU. When will clearance be given, and has it been applied for to date? What is the reason for the delay between clearance being applied for and its being granted? There is some ambiguity about the meaning of paragraph 10 of the explanatory notes, which states:
“The EIS has been notified to the European Commission as a State aid, but not yet approved.”
Does that mean that the increase to £500,000 has yet to be approved or that the scheme itself has yet to be approved? It is important for the Committee to know that. Have the Government commissioned research on the effectiveness of the relief in stimulating investment in high-risk businesses?

Angela Eagle: As for the hon. Gentleman’s point of order, we will certainly see if we can do anything in advance to assist the Committee’s proceedings. I am not sure when we are due to discuss schedule 17, but if we can make the explanatory notes more clear, we will do so.
It may help the Committee if I set out some background to the clause. The Government are committed to encouraging entrepreneurship, innovation and growth among smaller, higher-risk enterprises and to improving the United Kingdom as a place for businesses to start up, invest and expand. Venture capital schemes, including the enterprise investment scheme are important tools. They contribute to the Government’s wider policy of improving access to finance for small companies and tackling the so-called equity gap suffered by smaller companies struggling to obtain the finance that they need to grow into sustainable, profitable enterprises. As the Chancellor of the Exchequer said in his Budget speech, we need to do more to help small and medium-sized enterprises gain access to finance.
With that in mind, as the hon. Member for Fareham rightly pointed out, the clause increases the annual amount of investment on which income tax relief is available under the enterprise investment scheme from £400,000 to £500,000. As he suspected, that increase is subject to state aid approval and will apply only from 2008-09, once it has been brought into effect by Treasury order. To date, the enterprise investment scheme has helped to raise around £6.1 billion, invested in 14,000 small or high-risk companies. The increase in the annual investor limit is intended to stimulate further investment in such companies by offering a greater incentive to business angels and other individuals, particularly in the light of current financial market disruption. I might point out that the increase has been well received by industry. For example, the CBI confirmed that it welcomed
“the uplift in thresholds for the enterprise investment scheme which should encourage more investment in growth companies.”
The hon. Gentleman asked if the scheme has been notified to the European Commission. I can confirm that it has, but it has not yet been approved. The change described here must also be approved before it can come into effect. When that happens, the proposal is to make it effective from 6 April 2008 by means of a Treasury order. The scheme and the increase have both been notified, and approval is awaited for the combined package.

Question put and agreed to.

Clause 28 ordered to stand part of the Bill.

Clause 29 ordered to stand part of the Bill.

Schedule 11

Venture capital schemes

Mark Hoban: I beg to move amendment No. 82, in schedule 11, page 212, leave out line 28.

Jimmy Hood: With this it will be convenient to discuss the following amendments: No. 83, in schedule 11, page 212, leave out line 32.
No. 84, in schedule 11, page 213, leave out lines 1 to 5.
No. 85, in schedule 11, page 213, leave out line 16.
No. 86, in schedule 11, page 213, leave out line 20.
No. 87, in schedule 11, page 213, leave out lines 27 to 31.
No. 88, in schedule 11, page 214, leave out line 4.
No. 89, in schedule 11, page 214, leave out line 8.
No. 90, in schedule 11, page 214, leave out lines 15 to 19.
No. 94, in clause 30, page 15, leave out line 6.
No. 95, in clause 30, page 15, leave out lines 13 to 17.

Mark Hoban: This group of amendments probes schedule 11, which amends the rules for the schemes and carves out the three areas of shipbuilding, coal and steel. The explanatory notes to the schedule indicate that the carve-outs have been prompted by EU state aid rules, which specify the circumstances in which aid can be given to those industries. Schedule 11 cites three documents to justify that position: for shipbuilding, the framework published in the Official Journal of the European Union on 30 December 2003; for steel, the guidelines published on 4 March 2006; and for coal, article 2 of “Council Regulation (EC) No 1407/2002”, which was published on 23 July 2002. One question that immediately springs to mind is why the Government have taken so long to implement the regulations, since they have been part of EU rules for between two and six years.
I particularly want to discuss the amendments on the coal industry, which would remove the coal industry from the excluded activities in schedule 11. When I looked at the Council regulation, it appeared that it would still be permissible for aid to be given to the coal industry through venture capital schemes. For example, article 5 of the regulation deals with aid for accessing coal reserves, whereby aid for initial investment can be paid until 31 December 2010. It appears that under EU rules a VCT could invest in a company seeking to open up new coal reserves or exploit existing reserves until the end of 2010. However, the Government, through the changes in the schedule, seek to prevent that. When energy security is an issue—that is referred to in the regulation—we should be considering how best to exploit our domestic reserves. Some hon. Members will doubtless think about the environmental impact of mining more coal, but we currently have coal-fired power stations. Several people are looking to build new stations using clean coal technology. If nothing else, it could be argued that we should mine more coal. Why has coal been excluded from schedule 11 when, according to the Council regulation, coal mining could qualify for aid and it might be possible to encourage VCT schemes to invest in exploiting new or existing reserves of coal?

Angela Eagle: The amendment probes the schedule’s exclusion of shipbuilding and coal and steel production. As is clearly set out in the text of the Budget, that is necessary to meet European state aid regulations so that we can get approval for the three venture capital schemes and enterprise management incentives. We will thereby be able to continue to enable smaller, higher-risk UK companies to receive vital funding across the full range of industry. They will be able to use the investment management incentives to help recruit and retain staff. The Committee will no doubt remember that last year’s changes to the venture capital scheme were introduced for the same reason. The state aid and notification process is ongoing and, I hasten to add, it is going well. However, it became clear in the course of our negotiations that the additional exclusion in the schedule was necessary to demonstrate the scheme’s compliance with state aid for risk capital guidelines and for EMI.
We believe that, in practice, the exclusion of shipbuilding and coal and steel will have a minimal material impact. Analysis shows that fewer than 10 companies in all three sectors have used the venture capital scheme for the last 14 years, and no coal production companies have ever used the enterprise management incentives scheme. To date, about £1 million has been invested in companies in these sectors across the enterprise investment scheme, venture capital trusts and the corporate venturing scheme. To put it in context, that represents 0.01 per cent. of the funds raised under the tax-based venture capital schemes. Despite evidence of what happens in practice, we were obliged to put this matter on a legal footing by explicitly excluding those trades, and that is the purpose of the schedule. It is important to remember that state aid controls mean that British companies can compete fairly because their European competitors are being prevented from receiving unfair subsidies as well. There is a prize to be gained by successfully achieving state aid notification and approval for our schemes.

Mark Hoban: Does the Exchequer Secretary recognise that the rules set out in the EU Council regulation come into force on 31 December 2010? We seem to be having early adoption in the UK whereby in other EU member states aid can be granted similar to that which is prevented from being granted in the UK.

Angela Eagle: It is important to remember that the context for these exclusions is small start-up companies, and there are other capacities within EU laws for these industries to gain support.

Stewart Hosie: The Exchequer Secretary argued that the exclusion is necessary for EMI schemes and I do not doubt that. She said that there is a requirement to put this on a legal footing and I am sure that that is true. She is also right that there are other schemes for start-up companies.
I am not sure whether it has happened yet, but there is a determination to use carbon capture and storage with coal-fired power stations. There is a possibility that low-sulphur coal mines will be reopened. There may be new entrants to the market who wish to do that. Given that, and given the possibility of future energy shortages, will it be possible to revisit this issue if new entrants want to use CCS and low-sulphur coal and reopen existing fields?

Angela Eagle: It is important to realise that there are other opportunities for getting investment into those industries, and I do not demur from the analysis of the hon. Member for Dundee, East regarding the potential for innovation in clean coal technology. I would agree with that analysis. We have to remember that the UK has the most efficient coal industry in Europe, but until July 2002, European Union rules prevented the Government from supporting viable investment projects. Since its launch in 2003 under the regulations on state aid to the coal industry, the coal investment aid scheme administered by the Department for Business, Enterprise and Regulatory Reform has made awards of £58.5 million. In 14 years, less than £1 million has been invested using those schemes. The plain fact is that companies that need state support for developing the worthy things that we all wish to see with respect to clean coal technology, tend to be larger and established. They are not small, innovative, start-up businesses. In 14 years, before it became clear from our negotiations with the EU that those industries had to be excluded from the state aid schemes, partly because other EU state aid is available in those sectors, almost none—in fact, only 0.06 per cent.—of the money under these venture capital schemes had been used in the sector.

Peter Bone: Is the Exchequer Secretary arguing that we cannot do this because of EU regulations, or because of a decision by the Government, as it does not affect many companies?

Angela Eagle: I am arguing that it is because EU rules preclude us from doing it. If the amendments were passed, it is clear from our negotiations that we would fail to get state aid notification from the EU, and we would lose all three schemes, with all their benefits. That is absolutely clear. What I was hoping to do with the figures for those three sectors over the past 14 years was to reassure hon. Members that those exclusions will not produce a great effect. That overlap existed prior to our negotiations on state aid rules. The European Commission has made it absolutely clear that the coal industry must be excluded. The amendments, if passed, would jeopardise all the schemes, which I am sure is not the aim of the hon. Member for Fareham. He said at the start that they were probing amendments, and I take him at his word.

Mark Hoban: The Exchequer Secretary referred both in this debate and the previous one to the negotiations with the European Commission about the schemes. Is she saying that the only barrier to the schemes obtaining formal notification from the Commission is the exclusion of those three industries, or are there other issues that have been debated? If there are other issues, would she outline those to the Committee?

Angela Eagle: That is not the only barrier, but it is an absolute barrier. The Commission has made it clear that if we do not exclude those three sectors no state aid notification will be granted for the schemes, which would destroy them and produce the related negative effects. I am sure that the hon. Gentleman would agree with me that not being able to run the schemes would have a negative effect on our ability to support those companies that find themselves in what is known as the equity gap—in the middle of start-up and growth. There are other issues, some of which crop up in subsequent clauses, so I do not want to go into great detail now. I can assure the hon. Gentleman that the negotiations are ongoing. We are confident that we will be able to get state aid, and we are working through the issues as the European Commission raises them.

Mark Hoban: I am grateful for that clarification, which addresses some of the points that we will raise later. Would the Exchequer Secretary explain what the consequences would be if we did not receive approval for the schemes? Would the impact be retrospective, for example?

Angela Eagle: In theory, it could be retrospective to the beginning of the schemes, and it could require us to chase every grant that had ever been given to a company. I do not wish the Government to find themselves in such circumstances and I hope that the hon. Gentleman agrees.
It is in the interests of all our start-up companies that we maintain the schemes and the benefits that they convey. That is why we are working to avoid the worst-case scenario. If the changes to the schemes are not introduced, we risk a Commission investigation under article 88.2 of the EC treaty, which could lead to our having to withdraw the scheme or the associated tax reliefs and engage in what is known as aid recovery—reclaiming all the money, going all the way back. I cannot think of anything that I would rather the Treasury did not have to spend its time doing, which is why we are trying to be as helpful as we can in the negotiations for state aid.
I am sure that the amendment is a probing one, and that given the explanations that the hon. Member for Fareham has received about why certain sectors have been excluded, as well as their tiny presence over the years in this particular scheme, he will be sufficiently reassured to withdraw it.

Mark Hoban: I am grateful to the Minister for responding in such detail to the amendments, which are indeed probing amendments. She has helpfully shone a light on the process that we have to go through to get the schemes approved by the Commission. I hope—and I am sure that she will do so—that she will take a robust approach with the Commission. I share her view that it would be a dreadful waste of time and resources to try to chase up all the companies to recover the money, and it is important, therefore, that the schemes receive the approval that they need from the Commission. For people investing in those schemes, that process creates uncertainty in some respects, because the goalposts keep shifting, almost from year to year. I do not want to move on to the next group of amendments, but in previous years, £1 million was invested in schemes that are now excluded, and there may be other changes, which creates uncertainty about what is appropriate when managing the future development of a scheme. In light of the explanation that the Committee has received from the Minister, I would not wish to impede the approval of these schemes by the Commission, so I beg to ask leave to withdraw the amendment. [ Interruption. ]

Amendment, by leave, withdrawn.

Schedule 11 agreed to.

Jimmy Hood: Before I call the next group of amendments, may I tell hon. Members that I can hear murmuring in the Committee? If I can hear murmuring, hon. Members are not in order, and I ask them to pay attention to whoever is addressing the Committee. If they wish, hon. Members may take their jackets off.

Clause 30

Enterprise management incentives: qualifying companies

Mark Hoban: I beg to move amendment No. 93, in clause 30, page 14, line 16, leave out subsections (2) and (3).

Jimmy Hood: With this it will be convenient to discuss amendment
No. 97, in clause 30, page 15, line 22, after ‘by’, insert ‘subsections (4) and (5) of’.

Mark Hoban: I think that the debate on this group of amendments will proceed along similar lines to the previous debate. The rules affecting enterprise management incentive schemes are being amended through clause 30 with the introduction of a new test for qualification—an employee number test. That test will join a series of other tests set out in part 3 of the Income Tax (Earnings and Pensions) Act 2003, which deals with issues such as independence, having only qualifying subsidiaries, a gross assets test, and ensuring that businesses do not engage in excluded activities, which are listed in that provision. They are principally activities involving investment in significant property assets and real assets, whether intangible or tangible; financial services; and facilities management. I suspect that at the end of our proceedings coal, ship-building and steel will also be excluded. The amendments to clause 30 will introduce a further test to enable companies to qualify, requiring them to employ fewer than 250 full-time equivalent employees.
The Minister has set out the process that led to the introduction of that requirement, but it would be helpful for the Committee to understand why the magic number is 250 and not a lower or higher number. Unlike amendments in the previous group, there is no cross-reference to the relevant Council regulation or document to support that 250 cut-off. It would therefore be helpful if the Minister would explain where that requirement came from.
A couple of points of detail have emerged from representations that have been made to members of the Committee on clause 30. The Institute of Chartered Accountants has suggested that there should be guidance on who would need to work full-time and part-time so that businesses, when calculating full-time equivalents have some understanding of what rules should apply. Does that mean a 40-hour week or a 35-hour week, and does it mean that someone who works 20 hours a week is working half a week or two thirds of a week? Some indication from Her Majesty’s Revenue and Customs on that issue would be helpful.
The ICA has also suggested that, for completeness, those on adoption leave should be discounted alongside those on paternity and maternity leave when calculating the 250 figure. Because of the difficulty in calculating the number of full-time equivalents, it has asked whether HMRC will disregard minor breaches where it is evident that the company has taken reasonable steps to comply with the new requirements.

Angela Eagle: To put the discussion in context, the enterprise management incentives are intended to help smaller, higher-risk companies recruit and retain staff by allowing them to issue share options with tax advantages to employees. Provided that the conditions of the legislation are met, any gains from EMI share options are free from income tax and national insurance contributions, and that is the context of this debate. The hon. Gentleman asked a couple of questions about the changes set out in clause 30. He was right to point out that we have introduced a limit of 250 employees as a definition for those companies that will be eligible for the scheme. He asked why the figure is 250. It comes from the requirement that the Commission has laid down, because it is within the European Union’s definition of a small and medium-sized enterprise. As part of our ongoing discussions for state aid approval, that is what the Commission has suggested we base the figure on.
The national employers skills survey consistently finds that skills shortages in the labour market are most severe among companies with fewer than 250 employees, so there is an evidence base there. There is also the potential for market failure, with regard to the ability of companies of that size to attract appropriate staff to help them grow and expand, and that adds to the evidence base for the 250 figure. We have no other evidence to present to the Commission in favour of a different limit, which is why we have settled on the limit that it suggested. It has always been our intention, since the introduction of EMI, to target small and medium-sized enterprises. To that extent, I hope that I have given the hon. Gentleman the justification for what might have seemed, initially at least, to be an arbitrary figure. It is actually based on EU definitions and our own evidence base of skills shortages.

Mark Hoban: Would the Minister give us an indication of the points on which we won the argument with the European Commission? We have identified those issues where we have completely lost the argument, and I do not doubt the basis for that: 250 employees is seen as a limit for small and medium-sized enterprises.

Angela Eagle: First, we are having negotiations. We are not having an argument.

Philip Hammond: Of course.

Angela Eagle: There is a difference. Secondly, these schemes predated the guidelines for state aid that we are in the middle of negotiating. Essentially, we had schemes that were created before the state aid structures were created. We are therefore having discussions and negotiations with the European Commission to ensure that we can get state aid approval for pre-existing schemes so that they do not have to end.

Stewart Hosie: I think the 250-employee limit is very sensible, not least because it covers 277,000 of Scotland’s 279,500 businesses. However, there are other rules, including the one on £30 million of gross assets. Every European economy is different, so I wonder whether there is a breakdown of the proportion of businesses that might be eligible, country by country and nation by nation within the UK. The breakdown of SMEs in England is rather different from the composition in Scotland, where there is a small number of very large companies and a large number of very small companies. Do we have a comparative analysis, country by country, as that would be very helpful?

Angela Eagle: I am not sure that I have one to hand, but I take the hon. Gentleman’s point. These incentives are aimed at small and medium-sized enterprises, which comprise the bulk of businesses in the UK. There are other EU state aid arrangements for large global companies which would not become involved in this kind of very specific scheme. The aim of the scheme is to fill what is known as the equity gap, and to help small and medium-sized developing companies with high growth potential to attract employees, who will help them make that next step, and therefore convey the benefits of that innovative, high-growth sector to our economy. The hon. Member for Dundee, East is right: other European economies can have very different structures. The European Commission has to work within its own state aid rules to accommodate those differences.
I hope that I have managed to explain the point about the 250 employees for the hon. Member for Fareham. He asked how that would work as a definition, which is clearly important for companies that are close to that limit. Guidance will be produced shortly after Royal Assent. Guidance on similar points is already available in the venture capital manual. HMRC is happy to discuss any difficult cases or any cases where there may be some confusion among companies which qualify now, but think they might be quite close to the edge of not qualifying.
On the point about adoption, we have to follow EU guidelines, which do not currently include adoption leave. The UK is ahead of much of the rest of the EU in recognising adoption and parental leave. Some EU countries do it, but the vast majority do not. Again, HMRC is happy to discuss cases where this may be an issue. I hope that those answers satisfy the hon. Gentleman and that he is happy to accept the contents of the clause. Let me again reassure him that 6 per cent. of those currently receiving assistance will be excluded from the 250 limit. That is 400 out of the 7,000 or so companies that are currently benefiting.

Mark Hoban: Will the change have a retrospective impact on those companies with over 250 employees?

Angela Eagle: No. They will be able to keep the share options and advantages that they have to date, but they will not be able to access any more. That is how the change will work. With that reassurance, I hope that the hon. Gentleman is happy to accept the clause.

Mark Hoban: I am grateful to the Minister for the way in which she has explained the inclusion of the 250-employee limit. I am sure that those listening to the Committee’s proceedings will be interested to know that guidance is to be published on what “full-time” and “part-time” mean. Given that the words crop up often in the regulations, that guidance will be welcomed by many people.
I want to pick up the comment made by the hon. Member for Dundee, East. I wonder whether we have really analysed the interaction between the different limits and to what extent the gross asset test rules companies in and out. Is the interaction in danger of reducing significantly the pool of companies that can take advantage of the schemes, to the detriment of encouraging entrepreneurial activity in the UK? I leave that thought with the Minister, but I beg to ask leave to withdraw the amendments.

Amendment, by leave, withdrawn.

Mark Hoban: I beg to move amendment No. 96, in clause 30, page 15, line 21, at end insert—
‘(5A) The amendments made by subsections (2) and (3) of this section shall not come into force until the Treasury has laid before the House of Commons a report which sets out how companies deemed to be in a group because they are owned by a private equity and venture capital firms can become qualifying companies under paragraph 8 of Part 3 of Schedule 5 to the Income Tax (Earnings and Pensions) Act 2003.’.
This is a probing amendment that I want to explore with the Minister because it deals with an important group of companies that cannot take advantage of EMI and other schemes. They are small or medium-sized companies that work, in many cases, in high-risk sectors of the economy, have the same recruitment issues that the Minister outlined in relation to the previous amendment, and are owned or invested in by venture capital and private equity companies. The qualifying conditions for these schemes mean that firms owned by venture capital companies cannot take advantage of them because they will aggregate employee numbers, or the gross assets of companies owned by a single venture capital business or by a partnership that has invested in them, and potentially catch companies out through the independence rules. I recognise the importance of rules about independence and the aggregation of employee numbers and gross assets. They prevent large trading groups from circumventing the rules to qualify for those reliefs by trying to fragment their activities over a number of companies. One would not expect companies that private equity or venture capital have invested in, such as Boots or BAA, to be able to fragment their activities and qualify for these schemes. In the same way, one would not expect large companies not owned by venture capital to be able to take advantage of the same schemes. Many venture capital funds invest in start-ups, as well as small and medium-sized companies, but they sometimes lose out and cannot offer their employees EMI schemes. Nor do venture capital funds qualify for the research and development tax credits for small companies.
The Government have rightly stressed that there should be a level playing field so that companies owned by venture capital companies do not have any unfair advantage compared with those owned in other ways. That principle was established clearly and beyond any doubt in last year’s debate about the private equity sector. In this situation, small and medium-sized companies are unfairly disadvantaged compared with their peers that are not owned by venture capital partnerships. The British Private Equity and Venture Capital Association has been in discussion with the Treasury about this matter for some time, and I know that the issue exercises its members. I should be grateful for an explanation of how the Government can tackle it. How can we use the existing definitions of venture capital schemes in other legislation to create a framework to ensure that small and medium-sized companies operating in high-risk markets all receive the same advantages and can all participate in EMI schemes regardless of whether they are owned by venture capital businesses?

Stewart Hosie: Will the Minister turn her attention to what happens when a company goes into administration? Could part of it be saved by being purchased by a venture capital firm? It could be run as a stand-alone company, but the new-purchase part that comes out of administration could not benefit from EMI schemes. Such schemes could be the sort of incentive needed to keep the best staff and stop them drifting off.
I shall cite the real example of an engineering company that had lost a major contract and gone into administration. A venture capital outfit said that its core business was extremely successful. The company was small, with 85 highly skilled people, but because the venture capital firm had bought and developed two or three other companies over time, it did not need these rules. In those circumstances, we would still have, in effect, a stand-alone company that did not fit in with other parts of the business but needed time to grow and re-establish itself to win back some of the business that it lost. Is there sufficient flexibility to allow at least that part of the business to benefit from the EMI schemes? I ask that not because it would benefit that particular company or similar companies, but because it might be an added incentive for venture capital firms to see the opportunity to buy out something to protect it or to increase its growth in a way that was less marginal or more attractive if EMI schemes were available for the part of the business that was purchased. Will the Minister consider that example?

Angela Eagle: The hon. Member for Fareham was right to be wary and warn the Committee of the dangers of fragmentation and tax avoidance in the control arrangements. He rightly pointed to the nub of the issue. Clearly, there is a balance between making the schemes available in the widest possible way and not opening up loopholes that would be exploited by those who would fragment for tax avoidance purposes.
The enterprise management incentive scheme was introduced in 2000 to allow smaller, high-risk companies to grant share options with tax advantages to their employees. They have been a success, with more than 7,000 companies granting options to more than 100,000 employees by 2006. The scheme is aimed at smaller, independent companies that are less likely to have access to the finance needed to attract highly-skilled employees, and that is where we intend these schemes to assist. We need to keep that in mind when we are thinking about venture capital companies or, indeed, private equity. The provision has a control requirement so that EMI is available only to companies that are genuinely small and independent. As the hon. Member for Fareham said, that has a valuable role in preventing tax avoidance. I am not suggesting that private equity engages routinely in tax avoidance or any such thing, and I would not like anyone to think that I was, but unfortunately the tax avoidance industry will take advantage of any opportunities to exploit incentives. The balance to which the hon. Gentleman alluded is therefore important. Private equity-backed companies are more likely to have the financial resources to offer competitive remuneration packages to the employees they need in the companies they acquire. It is not obvious that the scheme should be routinely available to private equity. However, I am happy to say that we are in discussions with representative bodies in the area to see how to address their perceived worry about not having access to such schemes without creating avoidance opportunities—that is the key point—or opening up the incentive any wider than its deep and successful focus since its introduction in 2000.
In essence, amendment No. 96 would drop the amendments made to clause 30(2) and (3) until a Treasury report was laid before the House of Commons. That proposal is not sensible; again, it brings us back to our negotiations on state aid. Our amendments are necessary to secure state aid clearance of the EMI scheme. The Government are seeking to ensure certainty for companies by securing approval for the enterprise management incentive scheme. All member states have to be compliant with state aid guidelines. Non-compliance would risk the worst-case scenario talked about under earlier clauses. We are in discussions about this. We have to balance other methods of financing companies, particularly through venture capital or private equity, against the creation of avoidance opportunities. We believe that the focus of the scheme has been correct to date. With those explanations, I hope that the hon. Gentleman will withdraw his amendment.

Mark Hoban: The Minister is correct about the importance of striking the right balance between creating incentives for legitimate activity and encouraging tax avoidance. That underpins much of part 3 of the Income Tax (Earnings and Pensions) Act 2003. However, we must be careful not to get sucked into too rosy a view of private equity and venture capital. Before coming to the House, I had experience of working with people who have been backed by private equity and venture capital companies. They would not have argued that they were well rewarded by their backers. The money invested is capital for them to expand the business, not to pay the management fancy salaries, particularly at the smaller, higher-risk end. Boots and the Automobile Association are very different from the companies able to qualify under the tests, which have gross assets of less than £30 million and fewer than 250 employees. In such companies, many are paid low—if any—wages because their venture capital backers want to see them invest in growing the business, not in fancy cars and flash offices. We should not fall into the trap of thinking that their life is easy or that the money from the backers is on tap.

Angela Eagle: I hope that the hon. Gentleman is not trying to say that I think any such thing. I also hope that he agrees that the schemes are there to help those who have no other option. If we can find a way to incorporate other forms of support without creating those potentials for tax avoidance and while keeping the scheme focused, then we will certainly do that, and we are in discussions to see how we can. I am not talking about fancy salaries or cars either.

Mark Hoban: The Minister said that venture capital-backed companies might not suffer the same recruitment problems as those not backed by VC funds because they could afford to pay better salaries. In my experience, that is not the case—they suffer from the same recruitment issues as other high-risk ventures. Money is not there on demand from the backers to fund the businesses. Where additional investment is made at a later stage, a price is extracted for such investment. These ventures are as high-risk and have the same recruitment challenges as any small or medium-sized companies—it is an equally challenging environment. I welcome the Exchequer Secretary’s assurances that discussions are taking place with representative bodies to see whether the rules can be modified to enable these companies to benefit from this and from other incentives from which they are currently excluded.

Angela Eagle: As these schemes are directed at bridging the equity gap or market failure, if private equity or venture capital bodies or their representatives can demonstrate to us that there are still shortages and skills gaps caused by market failure, it would enormously assist their cause in this endeavour.

Mark Hoban: I am sure that the Exchequer Secretary’s words will not go un-noted by people in this field. It is easy for Ministers to be offered arguments to the effect that they cannot do something because of tax avoidance. I appreciate that, but in this case she should use her best endeavours to reach a situation that would encourage more entrepreneurial activity in the UK and expand the incentives to private equity-backed companies. In these economic conditions, we need to incentivise people to take risks and help to grow the economy. Given her reassurances about the discussions that she and others are having with the industry, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 30 ordered to stand part of the Bill.

Clause 31 ordered to stand part of the Bill.

Schedule 12

Tax credit for certain foreign distributions

Kitty Ussher: I beg to move amendment No. 123, in schedule 12, page 215, line 17, after ‘company,’, insert ‘provided that—
(a) the company is not an offshore fund (within the meaning of section 756A of ICTA),’.

Jimmy Hood: With this it will be convenient to discuss Government amendments Nos. 124 and 125.

Kitty Ussher: As this is the first time that I have taken the floor this morning, it may be appropriate for me to respond to the point of order raised by the hon. Member for Fareham at the start of the sitting, if that would be in order, Mr. Hood. He rightly pointed out that the numbers of the amendments to schedule 17 used in the explanatory notes were different from those on the amendment paper. I am grateful to him for pointing that out. I am advised that a complete set of explanatory notes for all the Government amendments to schedule 17 is on its way to the room forthwith. Since we are a little time away from discussing schedule 17, I trust that that will be sufficient for the hon. Gentleman. I assure him that there was no intention to mystify any further what is a rather technical schedule.
By way of background to Government amendments Nos. 123, 124 and 125, I should explain that schedule 12 will introduce changes to the system of taxing individuals who receive dividend income from shareholdings in foreign companies. The changes have effect for the tax year 2008-09 and subsequent years.
Since the Bill was published, it has become clear that some collective investment schemes are seeking to exploit the extension of the non-payable dividend tax credit by locating their cash or bond fund ranges offshore, primarily to secure tax advantages for their UK investors. That behaviour could carry a significant Exchequer cost and was not the intention behind our policy. In order to prevent that tax leakage, the Government amendments will exclude distributions from all offshore funds from the extension of the non-payable dividend tax credit. An offshore fund is already defined in legislation. The amendments mean that the position for UK investors in offshore collective investment schemes will remain exactly as it was before 6 April 2008.

Philip Hammond: It is a pleasure, Mr. Hood, to serve under your chairmanship for the first time on this Bill. The Minister has made the case for closing a gap that has opened up. We do not dissent from her view, but there is a concern here. The Minister indicated that some funds had already moved location to exploit what would have become a loophole. Clearly, their premature action has allowed the Government to intervene and amend the Bill during its passage through Parliament to close a loophole.
It is rather disconcerting that, with the vast resources that the Government have available, an avoidance opportunity of this nature was not spotted when the schedule was drafted. The Minister told us that substantial amounts of Exchequer revenue could be at stake. Presumably, if those seeking to exploit this loophole had been able to contain themselves for just another two months and not shown their hand until after the Bill had received its Third Reading, the Exchequer would indeed have suffered that loss of revenue as those avoidance opportunities were exploited and presumably then reversed in next year’s Finance Bill.
Can the Minister tell us, because it is not always clear how this works in government, what lessons the Government have learnt from this and what analysis of this problem has taken place within the Treasury? How are the Government moving to ensure that other such loopholes are not being opened up unintentionally in areas where the potential exploiters will not be so accommodating as to show their hand at a time when the Government are still in a position to deal with it?

Kitty Ussher: I am grateful to the hon. Gentleman for his question, which is very prescient. The answer is simple: we are in continuous dialogue with the various parts of the asset management industry. It is precisely because of that relationship of trust and close dialogue that they alerted us to the fact that this was taking place. Obviously, we have our own experts and lawyers and we seek to consult as widely as possible and as much as possible. We will always take prompt action where required.

Philip Hammond: What armoury would the Treasury have had if this loophole had not been spotted? If the Bill had been passed into law without the amendment, and the loophole had then been exploited, would HMRC or the Government have any tools available to deal with it in the interim, or would it have had to be reversed in the next Finance Bill?

Kitty Ussher: The hon. Gentleman is talking about a hypothetical situation because we have spotted it and so there will be no loss to the Exchequer. It is always possible in Finance Bills to legislate retrospectively. So, hypothetically, we would have made it entirely clear that this was not the intention and would have sought to remedy it at the earliest opportunity. The point is absolutely clear. In response to industry concerns, we are using the opportunity to do the right thing. I am grateful for the hon. Gentleman’s support in that regard.

Amendment agreed to.

Amendments made: No. 124, in schedule 12, page 215, line 18, after ‘(b)’, insert ‘the person’.
No. 125, in schedule 12, page 216, line 40, after ‘company’, insert ‘that is not an offshore fund’.—[Kitty Ussher.]

Philip Hammond: I beg to move amendment No. 71, in schedule 12, page 215, line 18, leave out ‘minority’ and insert ‘small’.

Jimmy Hood: With this it will be convenient to discuss the following amendments:
No. 72, in schedule 12, page 216, line 17, leave out ‘minority’ and insert ‘small’.
No. 73, in schedule 12, page 217, line 8, leave out ‘minority’ and insert ‘small’.
No. 74, in schedule 12, page 217, line 9, leave out ‘minority’ and insert ‘small’.

Philip Hammond: Section 31, which this schedule introduces, seeks to create a level playing field for the receipt by UK residents of dividends from foreign companies. That has become pressing, not because people in the UK are rushing out and investing in foreign companies more than they were, but because some companies have become foreign companies as a result of flight from the UK. Perhaps it is not always as a result of that, but it is a concern. It is also because of acquisitions such as that of Abbey by Banco Santander, and because of the re-domiciling of Shell. Many people who thought that they held solid old-fashioned British company stocks now hold shares in a foreign company. The measure is generally welcomed, in that it provides some clarity.
I hope, Mr. Hood, that if I stick narrowly to the amendments, we can have a brief clause stand part debate, and raise some slightly more general points about how the measure has been introduced and the next steps that the Government intend to take.
Amendments Nos. 71 and 72 to 74 are an unashamed attempt to embarrass the Government over their failure to use plain language. I accept that a Bill or any legal document contains definitions, and one can define things to mean what one wants them to mean. It would be perfectly possible for the Government to put into schedule 12 “black means of the colour white”. If that was what the definition said, everywhere that the word “black” was used in the schedule we would understand it to mean “white”. However, I have to suggest to the Economic Secretary that, with all the rhetoric about making legislation—especially tax legislation—simpler, it would not be a bad principle to try to stick to using words in their plain meaning, and where the plain meaning of a word is clearly one thing, to avoid using that word to mean something else.
The word “minority” to me has a plain meaning. It means “less than a majority”. It has a meaning in relation to shareholdings. The term “minority shareholding” is well understood. It therefore struck me as unsatisfactory to have the term “minority shareholding” defined as a shareholding of less than 10 per cent. That seems to be an arbitrary definition. Twelve per cent. is apparently not a minority shareholding. By extrapolation, I assume that the Economic Secretary would wish us to regard anything less than 90 per cent. as not being a majority shareholding. A holding of 89 per cent. in a company would not give you a majority, if 11 per cent. was not a minority.
My suggestion to the Government to avoid that nonsense is to use “minority” where it has its plain meaning and, where the meaning that the Government wish to import is not that which is normally understood, to use something different. I have suggested the novel approach of calling a 10 per cent. shareholding a small shareholding—[Interruption.] Well, my hon. Friend the Member for Weston-Super-Mare thinks that that might raise some issues, but my underlying point is serious, and I shall be interested to hear the Economic Secretary’s comments about that use of language, and whether she agrees with me that it is confusing.
More substantively, the underlying provision in the schedule is a result of a European Court decision—Manninen in 2002. The Government plan to introduce further measures in next year’s Finance Bill to extend the tax treatment—possibly with restrictions—to holders of what according to the Government’s definition is a majority shareholding in a company, namely, anything over 10 per cent. It will be interesting if the Economic Secretary can explain why there is a need for a two-stage process and why it is not appropriate to address the issues facing the holders of larger shareholdings at this time. What does she think the consequences of that would be? It will also be interesting to hear the Economic Secretary’s view on the implications of the Lasertec judgment—another ECJ judgment in 2004—which I believe suggests that the limit, if there is to be one, should be much higher than 10 per cent. and could be as high as 25 per cent.
While we are on the subject, I understand that HMRC is currently resisting claims for relief based on the Manninen decision—ahead of the schedule being enacted—and is seeking to distinguish the details of individual cases of claims brought by taxpayers from the precedent that Manninen sets. It is the view of the Law Society among others that in most, if not all, of those cases, the distinction that HMRC seeks to make is not justified. HMRC’s fear of the Manninen judgment appears to be the lack of a time limit on its application; I suppose that it is concerned that there could be back claims going back many years, perhaps running to tens of millions of pounds. Other European Court decisions in relation to tax, particularly value added tax, have opened up just that scenario.
Will the Economic Secretary explain to the Committee the retrospective effect of the provisions in the schedule? Will they apply only to new dividend distributions, or will they apply retrospectively to distributions received in previous years? If the provisions are extended in the 2009 Finance Bill to apply a similar treatment to larger shareholdings, is it the Government’s intention that that will be retrospective, at least to this year, or will the holders of larger shareholdings be disadvantaged in comparison to smaller shareholders?
It seems that there are two simple choices: either the Government can accept the logic of the Manninen judgment and use domestic legislation to regularise the position and deal with retrospective claims resulting from Manninen, or they can turn their back on the ECJ decision, legislate for the future only and require all those with historic claims to trudge through the courts in a process that is expensive and tedious for all concerned. It strikes me that the Government are not afraid to use retrospection—I had written that note before I heard the Economic Secretary not five minutes ago telling us that she would use retrospection if necessary to deal with any loopholes that appeared as a result of poor-quality drafting in the Bill. If retrospection is sauce for the Government goose, should it not also be sauce for the taxpayers’ gander, in a case such as this? I look forward to hearing what the Economic Secretary has to say about, in particular, the position of taxpayers with historic claims as a result of the Manninen judgment.

Kitty Ussher: I presume that these are probing amendments and they will not be pressed. There seems to have been some misunderstanding on the part of Opposition Members, which I hope I can clarify. On retrospection, I do not know whether the hon. Member for Runnymede and Weybridge misunderstood or did not understand what I said. In the hypothetical case to which he referred, I said that a very strong statement would be made because we always could use retrospection if required. That is different from landing an unexpected tax bill, which we should always avoid unless it is necessary, so the hon. Gentleman is making mischief, although the Committee will surely not agree with me on that.
The 10 per cent. shareholding limit is very simple. It is a generally accepted dividing line between small investments and those in which the shareholding is large enough for the shareholder to be more closely involved in company decision making. It is a proportion rather than an absolute amount. I counter the hon. Gentleman’s accusation that we are seeking to complicate the issue. It is a generally understood term.

Greg Hands: Can the Minister tell us who the 10 per cent. limit is generally accepted by?

Kitty Ussher: It is generally accepted by all our stakeholders, otherwise we would not have done it like this. There is no attempt to mystify—it is used in other legislation and I can provide details shortly.

Greg Hands: Would she name some of these stakeholders who define the 10 per cent. barrier as representing a significant shareholding?

Kitty Ussher: Perhaps I need to go back to the basic point. Our intention is to provide clear legislation. The legislation states precisely what we mean and we consult on all these clauses. There is no attempt to mystify, we have no interest in mystifying and we are clearly setting out what we said that we would do in the Budget, which is deal with 10 per cent. holdings first and with larger holdings later on. I can provide a complete summary of all the responses that we have had, if the hon. Gentleman would find it helpful, but the term is generally accepted. I have said it about five times, and it remains the case. Perhaps I can now refer to the points that the hon. Member for Runnymede and Weybridge made.
The policy is to simplify things for people who hold shares in and receive dividends from foreign companies. The hon. Gentleman mentioned a number of European cases, and I am happy to explain them. We are aware of the Manninen and Meilicke cases, but they are not driving the taxation change in front of us. The Manninen case indicates that providing less favourable treatment for foreign dividends infringes the principles of freedom of establishment and free movement of capital, but the UK position is different from the position in Manninen.
We have many double taxation agreements designed to relieve taxation of income in more than one country. Manninen does not deal with foreign tax credit relief available in respect of foreign dividends. The changes to the tax treatment of foreign personal dividends that we are proposing from 6 April 2008—I hope that this answers the question that the hon. Member for Runnymede and Weybridge asked about when it comes into effect—have no effect on the past treatment of foreign dividend income.
The hon. Gentleman also mentioned the Lasertec judgment, which indicates that the relief should be up to 25 per cent. As I have stated on several occasions, we believe that the 10 per cent. figure is the generally accepted dividing line between small investments and those where the shareholding is large enough for the shareholder to be more closely involved with the business and to influence company decision making. The Lasertec case was about the freedom of establishment rules within the EC treaty and the 25 per cent. figure referred to the degree of shareholding that would confer determinative influence on the company’s decisions and activities. That is not the issue here because ECJ issues are not driving the policy—it is a simplification measure.

Philip Hammond: It is interesting that when it suits Government Ministers, they refer to EU decisions, to which they are perfectly prepared to sign up, but they then say, “Actually we have a different view and our view will prevail”. The Minister used the term “small shareholding” in the last piece of brief that she read out. She has not addressed the substance of the amendment yet, and explain why the Government have chosen to use the word, “minority”, rather than “small”, which appears in her own briefing note. It is the more natural term to use and it conveys the meaning in question. Why is she choosing to use “minority” in a most unnatural sense?

Kitty Ussher: The hon. Gentleman is playing with semantics because he cannot engage with the issue. The legislation makes our definitions entirely clear in a way that the industry accepts. We can debate whether it should be higher than 10 per cent., but the intention in the schedule and the relevant clauses is absolutely clear.
The hon. Gentleman suggests that we are trying to be vague, but that is not the case at all. I have explained why it is 10 per cent. The legal drafting is precise and, therefore, accepting his amendments would cause far more confusion than we have at the moment.

Philip Hammond: I am disappointed that on my first opportunity to engage with the hon. Lady, I have found her answer unsatisfactory. I thought that she would at least concede that it is a good idea to try to use language in its natural meaning to make tax legislation intelligible to the average reader, although I am not sure who the average reader of schedule 12 to the Finance Bill is. It is extraordinary that the Government have chosen to use a term that has a meaning and rather perversely define it differently for the purposes of this legislation.

Kitty Ussher: I put it to the hon. Gentleman that the word, “small”, could mean small in monetary terms, whereas the term “minority” always implies a proportion. Since it is a proportion for which we intend to legislate, does he not agree that his amendments would make the position more confusing?

Philip Hammond: No. The hon. Lady has just said herself that a term can be defined. “Small” could be defined as 10 per cent. or less. I do not think that anybody would say that that is not the natural meaning of “small”. “Minority” has a meaning; it means a percentage of 49.9 recurring or less. That is my understanding, but perhaps she went to school in a different place from me—I am sure that she did so. [ Interruption. ] The Exchequer Secretary, from a sedentary position, wants to engage in a bit of class warfare.

Angela Eagle: Will the hon. Gentleman give way?

Jimmy Hood: Order. The Committee is getting somewhat distracted.

Philip Hammond: The Exchequer Secretary seemed to want to indulge in a bit of class warfare. Perhaps she wanted to probe whether the Economic Secretary’s comprehensive school was better than my comprehensive school.

Angela Eagle: I assumed that the hon. Gentleman went to an all-male school. There was no suggestion of class in my mind whatsoever.

Philip Hammond: Well, she would be wrong on that as well. We will not embarrass the Economic Secretary by asking her to state her credentials.
I have made my point. I did not intend to undermine the Bill, but to obtain confirmation from Ministers that in general terms they would prefer things to be transparent and words to be used in their plain meaning. Unfortunately, we have not obtained that reassurance from the Economic Secretary, but I will not press the amendments further.

Colin Breed: Broadly, I agree with the hon. Gentleman. Words are used within a context. In the context of shareholding, “minority” has a particular meaning. I do not think that the Economic Secretary has answered the question of why the people with a shareholding over 10 per cent. have to wait another year. That is the explanation that I would like to hear.

Philip Hammond: Well, the Economic Secretary did not respond to that. If she would like to do so, I am be happy to give way. Related to the question of whether the measure has a retrospective effect for taxpayers who received foreign dividends before April, I specifically asked whether the extension to larger shareholders will be backdated to April so that they are treated similarly to minority shareholders. It does not appear that she wishes to intervene, so if we have the opportunity to hold a stand part debate, perhaps she would revert to the point. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendments made: No. 124, in schedule 12, page 215, line 18, after ‘(b)’, insert ‘the person’.
No. 125, in schedule 12, page 216, line 40, after ‘company’, insert ‘that is not an offshore fund’.—[Kitty Ussher.]

Philip Hammond: I beg to move amendment No. 70, in schedule 12, page 219, line 16, leave out paragraph 24.
This is another probing amendment. It would delete from schedule 12 paragraph 24, which seeks to deny the use of the new tax credit on foreign dividends from non-UK companies for gift aid purposes. While addressing the need to create a level playing field across EU and European economic area companies for most purposes, the Government have sought, for reasons that I do not understand, to carve out an exception for the gift aid scheme. As drafted, the Bill excludes the use of dividends received from European companies or tax paid in respect of dividends received from EU companies in the gift aid scheme. Does not that infringe European Union treaty requirements by discriminating between EU companies and interfering with the free movement of capital?
The Minister sought to convince the Committee earlier that the Manninen judgment had nothing to do with the introduction of schedule 12, but that is not our understanding of the situation. It seems that the Manninen judgment would apply to the gift aid exemption that paragraph 24 will exclude. I do not know whether that is the result of sloppy drafting, or the first sign of a hitherto unannounced Government campaign to challenge the EU treaties.

Peter Bone: Hear, hear.

Philip Hammond: My hon. Friend is getting excited about that. Quite honestly, nothing would surprise us these days, but in accordance with the long-termism that the Prime Minister espouses, if that is the Economic Secretary’s intention, she will need to get the policy into the public domain in the next 48 hours if it is to comply with the Prime Minister’s time-scale agenda. I look forward to hearing what she has to say, and perhaps we can pick it up again once we hear her response.

Kitty Ussher: I must admit to having a little bit of a chuckle at the Opposition parties, which are yet again reverting to type by wishing to see everything through the prism of some kind of battle with the European institutions. Nothing could be further from the case. I shall explain why we have made an exemption for gift aid, and why I do not propose to accept the amendment.
The amendment would allow donors to use the new tax credits on dividends from non-UK companies to frank donations to charity under the gift aid scheme. The key principle that underpins gift aid is that donors can redirect UK tax that they have paid to charities. Where UK income tax is paid on dividends received from abroad, the principles behind gift aid allow UK tax paid by donors to frank gift aid donations. The new dividend tax credit, however, reflects tax paid outside the UK, so the schedule’s provisions simply reflect the fact that there is no UK tax to redirect. Therefore, I ask the hon. Gentleman to withdraw his amendment.

Philip Hammond: I understand the Minister’s point, but having accused us of reverting to type, which is nonsense, she has now adopted a “little England” approach on this. She has talked about the UK tax deducted and about making it available for the gift aid scheme. Does she have advice, in the light of the Manninen judgment, that the terms of paragraph 24 of the schedule are in fact compliant with the EU treaties and do not fall foul of the free movement of capital provisions? I understand her concern about the possibility that the UK Treasury would essentially be reimbursing to a charity revenue that it had not received from the taxpayer in the first place—my hon. Friend the Member for Wellingborough, who was very interested in what I said earlier, would no doubt entirely support that view. However, it is in the nature of the arrangements that we have with the EU that there will be occasions on which one national Government will effectively subsidise another because of the free movement arrangement.
I shall just ask the Minister a simple, factual question. Is the drafting of paragraph 24 based on specific legal advice that it will not fall foul of the treaty provisions? She made her case to the Committee very clearly, but it will not astonish her to know that I did not dream up this challenge to paragraph 24 on my own. There are serious professional bodies out there that doubt whether the measure will survive a challenge in the European courts. While it may be clear in her mind, it is not clear to professionals outside who take an interest in these things. It would be useful to know what legal advice she has received.

Kitty Ussher: We consult all the relevant bodies. I understand that there is a convention not to mention them specifically, but we consult all of them. I am aware of the organisation to which the hon. Gentleman refers, but we simply do not agree with it on this point. Preventing the new tax credit from franking gift aid does not place a bar on the free movement of capital. We believe that it is perfectly consistent with the way that the EU treaties currently work. We are always exploring definitional points in this area.

Philip Hammond: I asked a specific question. Does the Minister have legal advice to that effect.

Kitty Ussher: We have our own internal legal advice.

Philip Hammond: To that effect?

Kitty Ussher: Yes.

Philip Hammond: The Minister has heard the point and has made her response. Those who have a different view will no doubt now communicate with members of the Committee. If necessary, we will come back to this issue at a future point in our consideration of the Bill. In the meantime, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That this schedule, as amended, be the Twelfth schedule to the Bill.

Philip Hammond: There are a couple of other points that I should like the Economic Secretary to clarify for us. Will a taxpayer be able to claim the credit against the higher rate tax due for any foreign tax deducted in respect of the dividend, in addition to the deemed tax credit? Unless credit is available for all or part of the foreign tax paid, the taxpayer will have an increased tax liability compared with that of a holder of shares in a UK company.
Can the Minister confirm that section 397A(3) of the Income Tax (Trading and Other Income) Act 2005 does not refer to deductions by way of foreign tax? Section 397A(7), which the schedule imports into the Act, deals with deductions by way of foreign tax. It is therefore important to confirm for the record that section 397A(3) does not refer to the foreign tax deductions that have been dealt with in the newly inserted section 397A(7). Parity of treatment, which lies behind the schedule, does not apply to individuals who will be claiming the remittance basis of taxation—in other words, non-doms—in line with the revised provisions of the 2005 Act. In those cases, following other changes proposed in clause 65, there will still be a discrepancy between UK and foreign dividends. A higher rate taxpayer who is a resident non-dom will be subject to an effective rate of 25 per cent. on UK dividends, but a rate of 33? per cent. on foreign dividends, as they are charged at the higher rate of 40 per cent. on remitted dividends rather than the special 32.5 per cent. dividend rate, which applies to dividends that are taxed on an arising basis. Do the Government have legal advice on this, or is it their considered position that that discrimination between the dividends of UK companies and EU companies in respect of resident non-dom shareholders is lawful under the EU treaties?
Let me draw a couple of minor points to the Minister’s attention. The Income Tax Act 2007 contains a definition of grossing up. It states that the grossed-up amount is
“the amount produced by adding to a net amount that net amount multiplied by the fraction r ÷ (100-r)”.
That is a different calculation from the one envisaged in new section 397A. That will be rather confusing. We will have one definition of grossed-up amounts in new section 397A(2), but in new section 399 of the Income Tax (Trading and Other Income) Act 2005, we will have a different definition using the definition in the Income Tax Act 2007. It returns to the earlier point about trying to make all this understandable. Does it make sense to have a different definition of grossing up in new sections 397 and 399 of an Act? Could we not have avoided that by more careful use of language in drafting?
Finally—this is related point, although it is not a definitional one—the definition of grossed-up distribution is the distribution increased by tax withheld at source. The definition in the schedule says, “including special withholding tax”. Will the Minister explain why those words are necessary? Surely, a special withholding tax will always be included in the definition of a tax deducted at source. Since provision is already made in the definition of grossed-up distribution to deal with tax withheld at source, why do we need a separate reference to special withholding tax? Is there some special significance that other members of the Committee and I have missed?

Colin Breed: I intervened on the hon. Member for Runnymede and Weybridge a moment ago, and I wonder if the Minister would clarify the position regarding those people with shareholdings above 10 per cent. who will now experience a delay. Why are they being delayed for a year? Will the benefit be retrospectively applied?

Kitty Ussher: As we are on the schedule stand part debate I want to explain the basic effect of the measure, which is to simplify the system for people with shares in foreign companies. More than 95 per cent. of UK individuals in receipt of dividends from a foreign company will be entitled to the non-payable dividend tax credit. That will simplify the tax system for about 300,000 people. It is somewhat predictable, given the interventions of Opposition Members, who all posed valid questions that I will answer, that there should not be a general point of principle saying that they welcome the simplification and the deregulatory principles behind it. The provisions are welcome.

Philip Hammond: The Minister may have forgotten—she will be able to check the Committee report—but my opening words in addressing amendments Nos. 71 to 74 identified the purpose, and I said that the measure was generally welcome.

Kitty Ussher: I am delighted that that is now on the record so that everyone can see that the proposal is welcomed by all political parties.
As for hon. Members’ specific questions, the reason we are tackling 10 per cent. shareholdings now and moving on later is that we wish to proceed at a proportionate pace in consultation with the entire industry. We had reached a consensus by the time of the Budget on 10 per cent. shareholdings, so we thought it appropriate to make our decision then. We will continue to consult in the months that follow in order to put our general proposals forward.
 Mr. Hammond rose—

Kitty Ussher: I will give way to the hon. Gentleman, but he should have the courtesy to let me finish my sentence. We shall put forward our general points for larger shareholdings at the appropriate time.

Philip Hammond: It is customary in this place to indicate a wish to intervene at the point at which that wish arises. It is up to the hon. Member who has the floor to decide if and when to give way.
The hon. Lady says that she is consulting with the industry—which industry? We are talking about shareholders who hold shares in foreign companies, so it is not obvious with which industry she would be consulting. Presumably, she is not consulting with foreign companies about how they would like their UK shareholders to be treated.

Kitty Ussher: We always consult with all interested parties, and I have already said that I do not intend to list for the Committee exactly who we are talking to. The hon. Gentleman has listed representations from many outside bodies and we will work with those and others.

Greg Hands: Will the Minister give way?

Kitty Ussher: No, I am going to make some progress. I will give way to the hon. Gentleman shortly. Turning to the specific points, the second part of this reform will not be retrospective, and we will make announcements in due course with clarity. The hon. Member for Runnymede and Weybridge mentioned the way in which the provision relates to the higher-rate tax credit and a withholding tax. There is no effect on foreign tax credit relief; both types of credit are non-payable and therefore act only to offset UK tax liability due. According to statute, credit for withholding tax will be given before the dividend tax credit. After foreign tax credit relief has been offset against any liability to income tax the dividend tax credit will be deducted from any remaining tax liability. If the total credit relief available exceeds the UK income tax liability the excess is lost; it is not re-payable and cannot be used to offset other tax liabilities.
The hon. Member for Runnymede and Weybridge mentioned interaction with non-UK domicile rules. The schedule does not seek to change in any way the position for non-domiciled individuals who invest in offshore funds. I am delighted that the hon. Gentleman has read in some detail new section 397A of the Income Tax (Trading and Other Income) Act 2005. He makes the point that we have two separate definitions of “grossed-up”, but he is incorrect in his supposition. The definition in the Income Tax Act 2007 is a general tax provision; by convention a specific provision such as new section 397A, on which he is now an expert, overrules a general provision, so that is entirely clear in law. He asked if we think that the way in which we tax individuals using the remittance basis is legal. Of course we think that it is legal; that is why we are doing it. The new dividend tax credit will apply to dividends paid to remittance-based taxpayers to the extent that for such dividends brought into the UK and charged a tax, when taken with the change in the headline rate of tax for higher-rate taxpayers to 40 per cent., it will give a new effective rate of tax of 33.3 per cent.
In his detailed reading of new section 397A, the hon. Gentleman queried the point about deductions. I am advised that “deductions” in this part of the schedule means relief under UK tax law for things such as interest. It does not mean foreign tax that another country has deducted from a dividend, and that is the point of that part of the schedule. I trust that with those answers we can now proceed.

Philip Hammond: Will the hon. Lady give way?

Kitty Ussher: I should be delighted to give way to the hon. Gentleman, and I have also promised to do so for the hon. Member for Hammersmith and Fulham.

Philip Hammond: I am not sure whether the last point that the hon. Lady made was intended to address my question about why there was a need for words referring to special withholding tax, or whether it was not in fact included in the more general reference to deductions. I am not sure whether that point remains to be answered.

Kitty Ussher: I have explained to the hon. Gentleman the best advice that I have had on that point, which is that “deductions” does not mean foreign tax that another country has deducted from a dividend. On his specific technical point, I shall reflect further and write to him.

Greg Hands: May I take the Minister back to the consultation? She gave an abbreviated response to my hon. Friend the Member for Runnymede and Weybridge about whether it will include foreign companies. Presumably, she must have some idea about whether the consultation will include tax lawyers, tax accountants, small stockbrokers or bulge-bracket firms, and can give us some sort of steer on who will be consulted.

Kitty Ussher: I am interested in the issue that Opposition Members keep raising. We have no desire not to consult anyone on changes to the law, such as the one under discussion. We shall, of course, consult all the groups that the hon. Gentleman has mentioned. In addition, my right hon. Friend the Financial Secretary has set up a group specifically to look from a company—rather than an individual—point of view at the competitiveness of the UK taxation system. The door is always open, and I hope that that message goes out loud and clear.

Question put and agreed to.

Schedule 12, as amended, agreed to.

Clause 32

Small companies’ relief: associated companies

Question proposed, That the clause stand part of the Bill.

Mark Hoban: The simplification has been broadly welcomed by industry groups because it deals with situations perhaps involving partners in firms of accountants. Under previous legislation, it would have been assumed that their companies were associated by virtue of the fact that they were partners rather than because there was commercial interdependence between the companies. The provision, particularly in the advent of large partnerships comprising several hundred partners, is to be welcomed. However, other situations are still caught by section 13 of the Income and Corporation Taxes Act 1988 when, because people are connected, it deems that their companies are associated even though there is no commercial interdependence.
For example, let us consider companies that are owned separately by relatives. Can the Minister clarify whether discussions are taking place on simplifying that aspect of the rules? There are other ways in which to deal with the same issue in respect of the annual investment allowance.

Angela Eagle: The clause deals with associated company rules, and I welcome the hon. Gentleman’s support for the simplification process. Associated company rules provide a range of anti-avoidance protection measures within the corporation tax regime. For the purposes of claims for small companies rate, they do that by preventing directors or shareholders from fragmenting business activities in order to qualify artificially in some ways for reliefs that were not intended, an issue that we have talked about before.
The clause amends associated company rules to make it easier to establish the number of other companies with which a company is associated, thus removing a potential cause of undue compliance burden. That is brought into effect, as the hon. Gentleman has rightly identified, by the changes to companies rules that allow for much larger partnerships—sometimes of more than 1,000. Clearly, it is not viable to expect a run-down on partnerships of 1,000 by one person and for that person to have detailed knowledge of all the holdings of the other partners in a way that perhaps happened in the past when partnerships were smaller.
The provision is the first of what we hope will be a series of simplifications. The hon. Gentleman referred to another area and further meetings will be scheduled to see how we can simplify the associated companies rules further. The matter is complicated. The stakeholders with whom we are engaging know and admit that it is complex. We are continuing to engage with them and we hope that further changes and simplifications in other areas, hopefully along the same lines, will come out of our discussions. With that reassurance, I hope that the Committee agrees that the clause should stand part of the Bill.

Question put and agreed to.

Clause 32 ordered to stand part of the Bill.

Clause 33 ordered to stand part of the Bill.

Schedule 13 agreed to.

Schedule 14

Company gains from successful investment life insurance contracts: consequential amendments etc

Kitty Ussher: I beg to move amendment No. 98, in schedule 14, page 225, leave out line 7 and insert—
‘1A (1) Subsection (1C) of section 437 (general annuity business: income limit) is amended as follows.
(2) In paragraph (b)(ii), omit “capital elements and”.
(3) Omit paragraph (c).
(4) In paragraph (d), for the words after “2005” substitute “are so much of the payments under the new annuities as would be within the exemption in subsection (1) of that section if—
(i) section 718 of that Act were omitted, and
(ii) that exemption were an exemption applying in relation to companies as well as individuals.”
2 Omit sections 539 to 551A (corporation tax in respect of gains arising in connection with life policies etc).’.

Jimmy Hood: With this it will be convenient to discuss Government amendments Nos. 99 to 104.

Kitty Ussher: Clause 33 and schedule 13, which we have just agreed, are simplification measures, when combined with schedule 14, which is before us. They are about profits on life insurance policies owned by companies. Together they turn some 60 pages of legislation into three, including some of the transitional provisions, leading to far lower compliance costs for industry. I trust that that too will be welcomed by the Opposition.
Government amendments Nos. 98 to 104 show that we can take the simplification in schedule 14 slightly further by also repealing some rules that apply to a purchased life annuity owned by a company. The rules set out how to calculate the non-exempt part of the annuity, which is the taxable income part. Amendment No. 99 repeals the relevant legislation on the special tax rules, which are no longer needed to identify separately a taxable part of the annuity. Amendment No. 98 ensures that, following the repeals, the tax treatment of an insurance company’s profits from its purchased life annuity business remains the same. An insurance company must continue to calculate a non-exempt amount for the purpose of its tax computations, where the annuity is owned by a company, in the same way as it does now. To do so, it must apply the rules that apply to purchased life annuities held by individuals; those rules continue in force. Amendments Nos. 100 to 104 repeal a number of provisions that are no longer needed or that inserted amendments into legislation that is being repealed.
I regret that we were not able to introduce the amendments with the original published Bill, but only once the possibility of simplifying further came to our attention. I hope that all sides of the Committee will agree that introducing the amendments is the right thing to do.

Amendment agreed to.

Amendments made: No. 99, in schedule 14, page 226, line 23, at end insert
‘(further provisions about corporation tax in respect of gains arising in connection with life policies etc).
6A Omit sections 656 to 658 (purchased life annuities).’.
No. 100, in schedule 14, page 227, line 7, at end insert—
‘(aa) in FA 1991, section 76(1),’.
No. 101, in schedule 14, page 227, line 13, after ‘1999,’ insert ‘section 80 and’.
No. 102, in schedule 14, page 227, line 18, leave out ‘paragraph 25’ and insert ‘paragraphs 25 and 27’.
No. 103, in schedule 14, page 227, line 19, after first ‘paragraph’ insert
‘(b) of section 473(2) and the “or” before it, paragraphs 268(1) and (2), 269 and’.
No. 104, in schedule 14, page 227, line 21, leave out ‘paragraph 111’ and insert ‘paragraphs 111 and 141’.—[Kitty Ussher.]

Schedule 14, as amended, agreed to.

Clause 34 ordered to stand part of the Bill.

Schedule 15

Changes in trading stock

Mark Hoban: I beg to move amendment No. 75, in schedule 15, page 228, line 39, at end insert—
‘(4) This section shall not apply where an election under section 161(3) of the Taxation of Chargeable Gains Act 1992 is made, and instead the market value of the asset at the time of the appropriation shall, in computing the profits of the trade for the purposes of tax, be treated as reduced by the amount of the chargeable gain or increased by the amount of the loss referred to in subsection (1) of section 161 of the Taxation of Chargeable Gains Act 1992, and where that subsection and this section do not apply by reason of such an election, the profits of the trade shall be computed accordingly.’.

Jimmy Hood: With this it will be convenient to discuss the following amendments: No. 76, in schedule 15, page 231, line 6, at end insert—
‘(4) This paragraph shall not apply where an election under section 161(3) of the Taxation of Chargeable Gains Act 1992 is made, and instead the market value of the asset at the time of the appropriation shall, in computing the profits of the trade for the purposes of tax, be treated as reduced by the amount of the chargeable gain or increased by the amount of the loss referred to in subsection (1) of section 161 of the Taxation of Chargeable Gains Act 1992, and where that subsection and this paragraph do not apply by reason of such an election, the profits of the trade shall be computed accordingly.’.
No. 77, in schedule 15, page 231, line 22, leave out ‘paragraph 7 does not apply’ and insert
‘neither paragraph 7 nor section 173 of the Taxation of Chargeable Gains Act 1992 applies’.

Mark Hoban: I speak to amendment No. 75, which stands in my name and those of my hon. Friends. The change in this schedule is one of the more technical in this year’s Finance Bill. The change is slightly odd. It seeks to put on a statutory footing a tax treatment that dates back to 1955, raising the question of why that is needed for what seems to be an established part of tax law. I am sure that the Minister will address that in her remarks, but it might be helpful for the Committee if I give some background to the schedule.
The tax treatment stems from a case, Sharkey v. Wernher, that was heard in the House of Lords in 1995. The case held that a trader who had appropriated the stock from her business for private purposes should account for tax purposes for the profit that would have arisen had the stock been sold in the normal course of business, where the value of the asset sold was in excess of its cost. Lady Zia Wernher ran a stud farm, which was classified as a trading activity. She also ran a racehorse stable, which was not classified as a trading activity—in line with many people who have had experience of owning horses. It was deemed that when Lady Wernher transferred her horse from the stud farm to the stable, the stud farm accounts should show, as profit, the difference between the cost of the horse and its market value at the time of the transfer. Thus the notional profit on the horse should be taxed. That is different to the accounting treatment of taxable profit. Case law has extended that, to ensure that it applies to transfers within groups, or to when an asset has moved from being part of the trading stock of a business to being a fixed asset. Schedule 15 seeks to codify that longstanding treatment.
There are two schools of thought about the schedule. The first is that it is an unnecessary move—the practice has been long established so why do it now? That is reinforced by the fact that when the Income Tax (Trading and Other Income) Act 2005 was passed as a result of the tax rewrite process, it was decided not to enact the treatment in statute. The Rewrite Committee reported:
“We see no reason to doubt that the principles explained in Sharkey v Wernher continue to apply to the calculation of business profits. But it would be wrong to enact those principles while others doubt the position. The only way to preserve the law is to continue to rely on case law in this area.”
That hints at another school of thought, which is that the original 1955 ruling was flawed. Keith Gordon, a tax barrister, argued in an article entitled “Sharkey Revisited” in Taxation, on 24 July 2003, that
“the rule was susceptible to challenge on two broad bases. First because their Lordships had not had the advantage of evidence concerning the accounting treatment of such appropriations, and secondly, because (arguably) the importance of accounting principles became even more pronounced following the enactment of”
the Finance Act 1998, section 42. That principle is now reflected in the 2005 Act to which I referred. The Institute of Chartered Accountants stated:
“The proposal is that trading stock appropriated or otherwise ‘used’ by the trader for his own benefit should be treated as sold at market value. This treatment is contrary to the treatment under UK GAAP”
—generally accepted accounting practice—
“under which the transaction should be accounted for at either the cost price of the stock or at the price paid on disposal. FA 1998 section 42 states that taxable profits must be computed in accordance with GAAP unless an adjustment is required or authorised by law.”
The different treatment in the Sharkey v. Wernher case and UK GAAP shows a difference between accounting and tax profits. Schedule 15 emphasises that difference and, by having that difference between taxable profits and accounting profits, works against the Government’s stated desire to simplify the tax system. It would be useful if the Economic Secretary could clarify why the Government decided to add schedule 15 to the Bill. Is it, as Keith Gordon suggests in his article, that taxpayers have been much more assertive in questioning the continued applicability of the rule? There is also the wider point that the schedule enshrines in statute a further gap between the tax and accounting definitions of profits. One of the ways to make tax simpler is to align more closely the two definitions of profit. Why have the Government not chosen to go down that route?
Another issue that arises from the codification of Sharkey v. Wernher is that the rule—the 1955 judgment—has been relaxed in statement of practice A32. Let me quote again from Mr. Gordon’s article:
“Statement of Practice A32 gives rise to another interesting issue. The current draft of the new clauses makes no reference to the undoubted relaxation of the Sharkey v Wernher rule, assuming that the rule is valid. Consequently it would appear that property developers and other traders who appropriate stock which they have constructed, as a fixed asset of the business, together with other traders who receive (or whose family or household members receive) meals or other services from the business, will now find that they have to start paying tax on profits they have not made and that this will apply in respect of appropriations after 11 March.”
The statement of practice has allowed certain relaxations of the Sharkey v. Wernher rules. The concern that Keith Gordon outlined in his article is whether the statement of practice still holds and whether it is overruled by the schedule. It is customary in the restaurant trade for the manager or owner to take some bottles of wine from the cellar for personal consumption and not pay the full price for them. As I understand it, such appropriations have not been deemed to be subject to tax in the past.
Will the Economic Secretary clarify whether Mr. Gordon’s interpretation is correct that the schedule will overrule the statement of practice? Has she considered the administrative impact that that will have on small businesses, which will be required to compute the market value of the assets appropriately? Sometimes that is not entirely straightforward. For example, it could depend on the point that the asset has reached in its construction.
I understand that the VAT treatment of these appropriations is to tax them at cost rather than market value. It would appear that there is a very logical approach in the VAT system, which is entirely consistent with UK general accounting principles. A different approach is used for income tax and corporation tax.
Where an asset is transferred at market value from a company’s trading stock to its fixed assets under the Sharkey v. Wernher rule, it creates a notional profit on the trading account of a business, which would be subject to corporation tax. For CGT purposes, the base cost becomes the market value of the asset transferred. The principle also works in reverse. For example, a fixed asset is transferred into trading stock. To use Lady Wernher’s example, a racehorse becomes part of a stud.
Under current rules, an election can be made under section 161(3) of the Taxation of Chargeable Gains Act 1992 to transfer the asset into trading stock at its original cost rather than its market value. That means that any gain or loss on the transfer is taxed within the business’ trading profits rather than as capital gains. There is therefore no chargeable gain or loss on transfer, but they are dealt with as part of the trading activities of the business. It is not clear in the schedule whether election under section 161(3) of the 1992 Act can be made in respect of these transfers. Amendments Nos. 75 and 76 would make it clear that the election continues to be available for those businesses subject to income tax, by amending the 2005 Act, and corporation tax.
Amendment No. 77 deals with the transfer of assets between group companies. As drafted, paragraph 9 ignores the possibility that group companies might wish to make the election under section 161(3) of the 1992 Act to transfer the gain or loss to the trading account and be subject to tax through that route, rather than as a chargeable gain.
I would like some clarification from the Economic Secretary on why the Government have chosen to legislate for the Sharkey v. Wernher ruling. With the amendments, I am keen to ensure that there is clarity that the existing elections available to businesses and individuals will still be available under schedule 15.

Kitty Ussher: The hon. Gentleman raises a number of different questions and perhaps it will help the Committee if I first explain what we think the effects of the amendments will be. I believe that they are unnecessary, but perhaps they are probing amendments. I will then answer the specific points of substance before saying why we are legislating in this area.
The amendments seek to clarify how the market value rules introduced by clause 34 and schedule 15 intend to interact with similar rules for capital gains tax. They appear to be based on a concern that the legislation will override and affect the capital gains rules set out in sections 161 and 173 of the Taxation of Chargeable Gains Act 1992. I am sure that the hon. Gentleman will be relieved to know that that concern is unfounded. The schedule will have absolutely no impact on the operation of the capital gains legislation, and sections 161 and 173 of the 1992 Act will continue to apply in the same way as they do currently. Had our intention been to override those sections of the 1992 Act, we would have explicitly amended or repealed them. We have not done so because that is not our intention.
I remind the Committee that schedule 15 will do nothing more than maintain the status quo, including the way in which the market value ruling in Sharkey v. Wernher interacts with capital gains tax rules, and I will explain why that is the case. Businesses will continue to be able to elect to disapply the market value rule for the purposes of capital gains tax under section 161 of the 1992 Act, in the same way as they have done in the past. That will include companies within the same group, which will be able to make such an election as they do currently under the provisions of section 161 as applied by section 173. Therefore, I do not feel in general that those amendments are necessary, but hope that my explanation has provided some background.
Turning to some of the wider points, the hon. Member for Fareham wanted to know where the new legislation will leave the statement of practice to which he referred. The statement of practice A32, as it is properly called, is part of HMRC’s published guidance. That sets out how HMRC applies the market value rule in Sharkey v. Wernher in practice. Once the rule is legislated in the Bill, as we propose to do today, there will be no need for a separate statement of practice, but there will be no practical effect on businesses, which will continue to operate the rule in the same way as they have always done.

Mark Hoban: Is the Minister saying that statement A32 will continue to exist and form part of HMRC’s guidance, or will it be removed from that body of guidance?

Kitty Ussher: My understanding is that it will be removed, because it will no longer be necessary following the passage of this legislation.
 Mr. Hoban rose—
 Mr. Bone rose—

Kitty Ussher: That has provoked some excitement.

Mark Hoban: I am not sure that I would go so far as to call it excitement, but the Opposition have raised in relation to previous Bills the problem about relying on guidance to articulate the meaning of legislation. In this case, the guidance softened or provided exemptions to the status quo—as the Minister mentioned earlier—that are based upon the Sharkey v. Wernher case. If that guidance does not form part of HMRC’s body of guidance, those exemptions are swept away. The schedule provides no exemptions to permit the existing relaxation of those rules to continue to apply, and that is the problem.

Kitty Ussher: It appears that I am about to be advised on that point. The purpose is to maintain the existing situation. I will take a little step back and diverge from what I was about to say to explain why we are doing this. We have been asked to legislate on this by the normal types of body that one would expect—the trade associations and the accountancy and legal professions—because although the case law has been operating happily for the best part of 50 years, it seems that there is now some uncertainty in the system.

Peter Bone: Will the hon. Lady give way?

Kitty Ussher: I will give way, but I will first answer the question that was just asked. The statement of practice A32 will be obsolete, as I have just said, but there will be no effect on taxpayers. We do not believe that represents a softening of the case law, so perhaps that answers the hon. Member for Fareham. The exceptions, as he said, will remain, but statement A32 will be obsolete because it will be incorporated into law. I hope that clarifies the point.

Peter Bone: I am grateful to the Minister for giving way, as my question is on that point. If we are creating new legislation so that the guidance is removed, HMRC will be forced to interpret the new law and catch people who previously were exempted. I do not think that is what the Government mean to do, so will they look at the provision again?

Kitty Ussher: I understand the hon. Gentleman’s point, but I have explained that it is absolutely our intention not to change the way that the process is carried out. It is simply a translation from guidance into legislation. Following the points that have been raised, I will take it upon myself to re-satisfy myself with my team that that is indeed the case. That is our explicit aim, so although the hon. Gentlemen are right to raise the issue, I hope that we can reassure them.
The effect of the provision on small businesses, including restaurants, which the hon. Member for Fareham mentioned, will not give rise to any additional administrative burdens. Its effect will be to maintain the existing treatment of movements of goods into and out of trading stock. No business will, as a result of this legislation, be required to do anything different from what they currently do. We are simply responding to concerns that it would be helpful to put the measure into law.
The hon. Member for Fareham asked whether the statement of practice is lawful, following the Wilkinson case. The decision of the House of Lords in Wilkinson concerned the proper authority of HMRC to make concessions from the strict application of tax law. That decision has no bearing on HMRC’s statement of practice, A32, or other published guidance, which, as I have already said, will now become obsolete; it will merely confirm that the market value applies only to goods, not to services, in line with tax case law subsequent to Sharkey v. Wernher.
The hon. Gentleman mentioned the report in Taxation magazine, which said that the House of Lords decision was not informed by evidence of accounting treatment and that the rule is therefore susceptible to challenge. We believe that Sharkey v. Wernher is sound case law based on a decision by the highest authority in the UK and that it has not been overturned by any subsequent court decision. We have simply been asked to include that result in legislation and I hope that we are doing so uncontroversially.

Mark Hoban: If the rule stands and has been decided by the highest court in the land, why does it need to be included in the Finance Bill? We do not seem to be changing anything by doing so.

Kitty Ussher: I hoped, innocently and naively, that I could deal with the substance and then with the timing issues. Perhaps I should deal with the timing now. Why is this measure being included in legislation? There is no evidence that the market value is not being applied in practice, but as modern accounting standards have developed in the past 50 years there has been a degree of uncertainty about whether the principles established by tax cases continue to override the relevant accounting standards, which of course they do. To put the matter beyond doubt, the Government are putting the principles arising from Sharkey v. Wernher on a statutory basis, because we want the tax system to be as clear as possible and to operate on the principle that areas of uncertainty should be addressed wherever possible. The measure supports that aim and puts the position beyond doubt.
The hon. Gentleman asked why we abandoned our plans to legislate on the market value principle as part of the tax law rewrite project in 2000. We intended to do so, but some respondents felt that as the rule was not previously contained in law, to include it in a law rewrite was inappropriate. That is a grey area, but we thought it best to err on the side of caution, so the relevant provisions are excluded from the tax law rewrite Bill. However, including such a thing in the Finance Bill enables us to debate the matter properly and get the issues on record. I hope that we have achieved that.

Mark Hoban: I am grateful to the Minister for her remarks on the amendment and those covering the broader issues relating to the schedule. I am particularly grateful for her clarification about the availability of the election under section 161(3) of the Taxation of Chargeable Gains Act 1992, which was the main concern raised by one of the representative bodies. It was felt that it was not clear previously.

Kitty Ussher: I should like to make it crystal clear that we set out not the exemptions to the codes, but the operation of case law. But the point is the same.

Mark Hoban: That is in relation to statement of practice, A32, rather than the availability of the election, which I was touching on. I am grateful for the Minister’s clarification that the election is still available. That is important.
We have a clear position on the statement of practice, A32, which the Minister just raised. However, although she was saying that A32 explained case law, surely that case law has been overridden by schedule 15. Although the Government were confident that the case was still the right one, the problem is that it was subject to greater challenge. Does that not have precedent over previous cases that have explored the measure? I think that in the past there was even a case over the cost of a bottle of wine.
I do not wish to detain the Committee for too much longer, but we need a clearer understanding of the status of the previous guidance and whether the schedule now applies to all cases where assets are appropriated from trading stock for personal consumption or are moved from fixed to trading assets. Another of the representative bodies has raised that point and it is important. It leads to an enshrining of the difference between profits as defined by UK GAAP—generally accepted accounting practice—and profits as defined by tax law. I suspect that will continue to be an issue as accounting practice develops to reflect changing circumstances. We are in danger of making a system more complex by maintaining the distinction between accounting profits and tax profits.
With the reassurances that the Minister has given on the section 161(3) election, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 15 agreed to.

Clause 35 ordered to stand part of the Bill.

Schedule 16

Non-residents: investment managers

Mark Hoban: I beg to move amendment No. 78, in schedule 16, page 232, line 14, leave out paragraph 2.

Jimmy Hood: With this it will be convenient to discuss the following amendments: No. 79, in schedule 16, page 232, line 28, leave out paragraph 3.
No. 80, in schedule 16, page 232, line 28, leave out paragraphs 3 to 6.

Mark Hoban: I want to speak to amendments Nos. 78 and 80 because amendment No. 79 is made redundant by amendment No. 80—as no doubt the Minister will point out. These amendments are about a point of principle rather than the underlying tax treatment. There needs to be certainty in the tax system and an appropriate process by which tax law is made and changed. Those matters are relevant to the schedule.
The investment management exemption enables UK-based fund managers managing overseas domiciled funds to avoid any income or corporation tax charges on profits made on the funds that would otherwise arise. For a fund manager to qualify for the exemption, transactions that they undertake must fall within the definition of an investment transaction set out in section 127(13) of the Finance Act 1995. That provision has been supplemented by four statutory instruments and augmented by a statement of practice; in this case it is SP1/01, which gives further guidance on the application of the exemption.
The fund management industry has argued that using primary and secondary legislation to define an investment transaction is not flexible enough to deal with the rate of innovation in the industry, so an alternative approach needs to be found. The proposal in the schedule is, therefore, to repeal the primary and secondary legislation and, in effect, to give HMRC’s commissioners the power to determine what constitutes an investment transaction.
As I understand it from representations on the provision from the Investment Management Association, the expectation is that HMRC will publish on a website transactions that it considers to be investment transactions, therefore qualifying to secure the exemption. That will mean that investment managers will not need to seek pre-clearance as often as they do now, because there will be much greater transparency about what qualifies under the rule, and they will be able to consult the website to see whether clearance has been given, and will need to approach HMRC only when a new type of transaction that has not been dealt with before comes into view, and they want to use it.
So the approach of the schedule is to remove inconsistencies between the legislation and the statement of practice not by refining legislation or making sure it is up to date, or redrafting it in a more encompassing and clearer way, but just by scrapping legislation that, it would appear, is inconvenient. I do not think that that is how this Parliament makes tax law. We believe that it is for Parliament, not the commissioners, to decide on tax. The schedule removes Parliament’s right to do so.
Parliament should have the right to scrutinise changes in tax policy, through scrutiny of primary and secondary legislation, and it is in the interest of proper, considered debate that the making of the changes should be scrutinised in public by Parliament, not discussed behind closed doors. Furthermore, it is in the interest of certainty that the principles of what is or is not an investment transaction should be laid down in statute. How would investment managers be able to challenge, argue or discuss the decisions reached by HMRC without a statutory framework within which to work?
Although in the short term certainty will be achieved by the elimination of primary and secondary legislation, the lack of clear, consistent statutory principles will, in the long term, create uncertainty if contradictory or ambiguous conclusions are reached. We had debates last year on guidance produced by HMRC with respect to capital losses; despite two iterations when we debated it in Committee, ambiguous conclusions were still reached about whether certain types of transaction fell within the laws. Guidance itself is not perfect in bringing about a considered view.
London has a poor reputation in the financial services sector for uncertainty. Our competitive position in the long term is strengthened by clear, consistent legislation that is properly drawn up. If there is a problem for fund managers, arising from the gap between legislation and the statement of practice, the answer is to refine the legislation rather than scrap it. That is the purpose of amendments Nos. 78 and 80—to restore or maintain the status quo and ensure that the changes are dealt with through proper legislative means, with full parliamentary scrutiny, rather than by the commissioners for Revenue and Customs.

Kitty Ussher: As the hon. Gentleman has just said, the amendments would remove from schedule 16 the provisions replacing the current definition of “investment transaction” in primary legislation with a new power, allowing the commissioners for HMRC to designate in regulations any transaction as an investment transaction.
It may be of use to Opposition Members if I say that our approach is favoured both by the Alternative Investment Management Association and the Investment Management Association, which, together, represent the overwhelming majority of industry participants. During the consultation, AIMA said that the industry wanted a new approach that would
“amend the legislative procedure to simplify/speed up the approval process”
for new transactions, and noted that the
“ability of the UK tax authorities to respond quickly to changes is important in a rapidly evolving industry”.
Schedule 16 delivers those benefits and is what the industry wants.
I take the general view that the City of London and the financial services sector is a jewel in Britain’s crown and one of our most important industry sectors, employing more than 1 million people throughout the country. Currently, about $400 billion is under management in the UK, and we are No. 2 in the world in the sector. Hundreds, perhaps thousands, of people are employed, so when the main industry bodies say that we can do something to make us as attractive, if not more attractive, to investment and expansion in the future, that is something that Governments of any colour should listen to. The amendments would undermine the approach that we are taking and leave the law exactly as it is. That is contrary to what the industry expressly sought during consultation and would mean that we could not deliver the simplification and speedy response to product innovation that are the drivers for what we are trying to do here.
I understand the general point that the hon. Gentleman makes. It is good government to scrutinise as much as possible in Committee and on the Floor of the House. We have sought to square the circle by giving positive assurances. HMRC has already given assurances as to how this power will be used. It is important that these are on the record, so I shall briefly reiterate them. All transactions that currently meet the definition of “investment transaction” in primary legislation will be included in the regulations made under the new power, so investment managers can be reassured that all transactions that currently qualify will continue to do so. HMRC has also said that it will agree with the industry and publish in guidance a statement of assurance about handling any future changes to the transactions that qualify for the investment manager exemption.
HMRC is also committed, as indeed am I, to maintaining the dialogue with the industry and its representative bodies in relation to this and other issues of interest or concern—the dialogue out of which these proposed legislative changes have themselves arisen. It may be helpful if I set out how I see this working in practice. HMRC would not spontaneously decide that a new type of product should be added to the list, but the industry would tell us about an innovation or a new type of derivative that it wants to trade in because it thinks that it would help its business. The product would not be doing any harm to anyone else, and industry will ask us to clarify that the rules mean that it is still exempted. We will have a look and say yes.

Mark Hoban: Will the Minister outline what principles HMRC will use in determining whether the proposed product would meet the criteria and so be acceptable?

Kitty Ussher: I am sure that the hon. Gentleman will agree that it is not for me to say that right now. I have said that HMRC will be working with the industry to produce this. It will be done collaboratively. The process has not yet finished. The whole aim is to simplify and speed up, and to make sure that we can retain our comparative advantage in this area. I therefore urge the Committee to resist the amendment and to allow the legislative changes sought by the investment management industry to proceed.

Mark Hoban: While I share the Minister’s view about the importance of the financial services sector—it is a tremendous contributor to Britain’s tax revenues, to employment and to economic growth, and it has grown faster than the economy as a whole in recent years—we need to be careful about introducing changes such as this. There are other features about the environment in which businesses work that are important. One of those relates to certainty. In the study produced recently by the City of London Corporation on tax as a motivation for the location of business in the financial services sector, one of the areas in which the UK rated poorly was certainty of tax law. While it may be convenient for the industry now to offer this approach, in the long term is it appropriate to proper governance to go down this route? That is why I asked about the principles that HMRC will use to determine whether new products satisfy the rules.

Kitty Ussher: Does the hon. Gentleman suggest that we should set out what type of transactions fall under the new power without consulting with industry first?

Mark Hoban: Far from it. We have seen plenty of examples of where lack of consultation caused the Government problems. We shall come on to some of those later. There should be proper consultation, but my argument is about determining some clear, unambiguous principles that are accepted by both industry and HMRC as to what transactions will qualify as investment transactions. If all of those criteria can be satisfied, why not have them set out in primary legislation? Why not have those principles set out in the Finance Bill, or even in a statutory instrument, rather than in guidance, which Parliament has no opportunity to scrutinise through this process or in a delegated legislation Committee? That is what I am trying to get at.
The Minister is at risk of failing to observe proper parliamentary process or to consider whether there are ways in which the same aim could be obtained through primary legislation rather than relying on guidance. That is the area that I am trying to explore, and I am yet to be convinced that I should withdraw the amendment. The Minister has not been convincing or persuasive as to whether the Government considered an appropriate legislative framework rather than reaching for guidance first.

Peter Bone: I urge my hon. Friend to press his amendment to a vote, because it is a major leap into the dark to give the Revenue decision-making powers without establishing the principles in the first place. The Minister gave no assurance that there would be any principles. It seems that the Revenue will simply come to a decision.

Jimmy Hood: I call Peter Hoban.

Mark Hoban: Mark Hoban.

Jimmy Hood: I am sorry, Mark Hoban.

Mark Hoban: We are easily confused on this side of the House.
My hon. Friend makes an important point. The Minister said that HMRC would seek to come up with some principles in collaboration with industry, and that is the right way to do it. The process should be consultative and collaborative, which is in the best interests of HMRC, the Treasury and industry. However, we should not cast to one side the proper process, which is through primary and secondary legislation, to reach a point that is acceptable to both industry and the Treasury. Does the Minister have anything to add?

Kitty Ussher: Absolutely. In the interest of my work, I am delighted that the Conservatives are pursuing this approach because it seems to be proof, if any were needed, that they do not understand the sort of derivative products that we are discussing. Huge principles are not required because we are talking about technical derivative products and whether they are added to a list. What is happening is simply that Britain is losing out because of the process that would otherwise be required. We would have to sit here and debate incredibly complicated matters that have no wider principles that need to be discussed at parliamentary level. I am absolutely clear that what we are doing is right for the City of London and for the financial services sector. There are precedents for it, and it is being used in other areas, such as in relation to the power given to commissioners of HMRC to designate the Stock Exchange as a recognised stock exchange.
I do not seriously think that what we are doing today would undermine the role of Parliament, because these are fairly mathematical transactions and we would slow down the City of London’s competitiveness by not pursuing this approach. That is what the industry unanimously said, and I would be delighted if the hon. Gentleman pressed his amendment to a Division, because it would show that he simply did not understand.

Mark Hoban: Well, that was an impassioned outburst from the Economic Secretary on what is an abstruse technical issue. If principles can be determined as part of the whole process of reassurance, is it not possible for those principles to be converted into primary or secondary legislation? That is the point that I want to tease out and we are getting a better understanding of the issue, but why does the Minister believe that primary legislation cannot be used? If HMRC and the industry bodies are looking to produce a statement of principles, why can they not be converted into legislation?

Kitty Ussher: The hon. Gentleman is not intervening on me. I have made my point.

Mark Hoban: I asked the Minister a question and I was hoping that she might respond. We are talking about a change in the existing process—

It being One o’clock, The Chairmanadjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Four o’clock.